Magellan Midstream Partners, L.P. Teams Up to Deliver Higher-Octane Returns

Markets Motley Fool

Magellan Midstream Partners (NYSE: MMP) currently has more than $1 billion of expansion projects under construction that should enter service over the next two years. Most of these projects will deliver exceptionally high returns, with the company targeting a six to eight times multiple of earnings before interest, taxes, depreciation, and amortization (EBITDA), or about a 14% yield on capital at the midpoint. One project, however, stood out because the company only expected a return of 12 times EBITDA on the initial phase. Given the weaker returns of that project, it would make it harder for Magellan to maintain its current distribution growth pace of 8% per year, especially considering that, until recently, it lacked other visible projects coming down the pipeline.

Continue Reading Below

That said, Magellan announced this week that Valero Energy (NYSE: VLO) would join it as a partner to expand that facility further. That deal should improve the overall returns of that project, and when combined with some other recent expansion project announcements, gives investors increasing clarity into the company's ability to continue to grow its distribution after next year.

Getting bigger and better

Last July, Magellan Midstream Partners announced that it would commence construction of a new marine terminal in Pasadena, Texas. The first phase of that facility would include 1 million barrels of storage, a new marine dock that could handle Panamax-sized ships and barges with up to a 40-foot draft, and pipeline connectivity to its existing Galena Park facility. The company expected to invest $335 million in that first phase, which would generate a 12 times EBITDA multiple, or about $28 million of annual EBITDA, when it entered service in 2019 given the long-term contracts it had in place. However, it noted that it had the space to expand the facility to include up to 10 million barrels of storage and five docks. Those future projects represented $1 billion of investment at an even more compelling eight times EBITDA multiple.

After signing the agreement with Valero this week, the company will now move forward with a second expansion phase at Pasadena. The 50% joint development agreement covers the entire facility and will enable Magellan to build an additional 4 million barrels of storage capacity, a three-bay truck rack, and a second marine dock that can handle Aframax-sized vessels with up to a 45-foot draft. The partners will also connect the facility to Valero's Houston and Texas City refineries as well as the Colonial and Explorer pipelines. The total investment for the two phases will be $820 million, funded equally by both partners. Furthermore, long-term contracts fully support each phase, which will come on line in early 2019 and 2020, respectively.

Improving visibility

Continue Reading Below

This agreement does several things for Magellan Midstream Partners. First, it will improve the overall returns it will earn on its $410 million investment in the project. It makes it much more valuable to customers as well, given the increased connectivity to other pipelines and the ability to handle larger vessels, improving the likelihood of additional expansion phases. Finally, it enhances the clarity of Magellan's ability to continue growing its distribution to investors.

Given the $1 billion of expansion projects Magellan had underway to start the year, it anticipated that it could increase its distribution by 8% this year as well as in 2018. However, with lower-return projects on the docket after that, it appeared less likely that the company could keep up that pace in 2019 and beyond. However, it has significantly improved its visibility this month, after announcing two additional expansion projects last week, including a $150 million oil pipeline in Texas and a $375 million joint venture with Valero to expand its refined projects system, both of which should enter service by mid-2019. Add those projects to the Pasadena expansion and Magellan has now secured more than $600 million of incremental investments these last two weeks that help support distribution growth in 2019 and 2020.

Refilling the tank

Magellan Midstream Partners' focus this year has been on securing additional expansion opportunities so it could continue increasing shareholder distributions beyond next year. With the two Valero joint ventures and the Texas oil pipeline, that now appears much more likely, especially given that its latest deal with the refining giant will boost project-level returns while also adding a new phase of growth. That gives investors much more confidence that Magellan can continue to be the high-growth, high-yield company they've come to expect over the years.

10 stocks we like better than Magellan Midstream Partners
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the 10 best stocks for investors to buy right now... and Magellan Midstream Partners wasn't one of them! That's right -- they think these 10 stocks are even better buys.

Click here to learn about these picks!

*Stock Advisor returns as of September 5, 2017

Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool recommends Magellan Midstream Partners. The Motley Fool has a disclosure policy.